Should I get a fixed-term annuity?

Updated 01 June 2020

Nick Green

Financial Journalist

Updated 01 June 2020

A fixed term annuity can offer you both the security of a regular retirement income and the flexibility to invest in a different product later.

If you like the idea of a regular income in retirement, but also the flexibility to change your mind later, a fixed term annuity could be a good option. Sometimes called short-term annuities, these products last from anything between one to 20 years, though five to ten years is typical.

Unlike a standard annuity, a fixed-term annuity means you’re not tied in for the rest of your life, so you can reassess your options when it comes to an end.

What is a fixed term annuity?

A fixed term annuity is an insurance product that pays you a guaranteed income for a set amount of time, followed by a lump sum (a ‘maturity sum’) paid when the annuity ends. You can then use this lump sum however you wish (such as by looking at other pension options, e.g. buying another annuity or opening a drawdown scheme).

How do fixed term annuities work?

When you buy a fixed term annuity, you pay a lump sum in return for a regular retirement income. You can usually decide whether you receive income monthly, quarterly or annually. The income you receive will depend on

• the amount you pay
• your provider’s annuity rates
• the length of the annuity
• personal factors such as your age and state of health

The money you pay for the annuity is invested by your provider at a fixed rate of growth. At the end of the annuity period, you will receive a maturity sum, which is your original investment plus growth, minus the income you’ve received in the meantime.

The amount of income paid to you directly affects the maturity sum you receive. So if you choose to have a lower annuity income, you’ll receive a higher maturity sum at the end.

If you die before your fixed term annuity ends, the rest of the money will usually be paid to a beneficiary of your choice. How this works will depend on your provider and the terms you’ve agreed between you. If you’re unsure, seek independent financial advice on this.

How are fixed term annuities taxed?

Any annuity payments you receive will be taxed in the same way as normal income. Remember however that you can take 25 per cent of your pension pot tax free, so you should do this before buying your annuity.

What are my options with a fixed term annuity?

Fixed-term annuities are noted for their flexibility. You have control over many features such as:

• The term (usually between five to ten years)
• Single or joint (to also cover a spouse)
• Guaranteed or investment-linked income
• Add-ons, such as death benefits and inflation-protection

How do I buy a fixed term annuity?

When considering a fixed-term annuity, always shop around. A financial adviser can help you do this. Different providers will offer different rates, and the right choice can save you thousands of pounds over the longer term.

Fixed term annuity rates indicate how much you will receive each year for every £100,000 you invest. For example, if you are offered a rate of 5 per cent and you pay in £70,000, you will receive £3,500 a year (followed by the maturity sum at the end).

Once you’ve chosen your annuity, you can apply for it yourself through the provider or go through your financial adviser.

What are the benefits of fixed term annuities?

• Flexibility – you can tailor the product to suit you and you’re not tied in for the rest of your life.
• Security – you’ll receive retirement income each year and for a set amount of time. You could choose a guaranteed income product if you want to know exactly how much income you’ll get, but it might not be cost-effective.
• A chance to earn more – if annuity rates improve, your maturity sum could increase. And at the end of the term, you could take out a new product with a better rate or benefit from an enhanced annuity if your health has deteriorated.

What are the disadvantages of fixed term annuities?

• Annuity rates may fall – if rates fall during the term, the maturity amount you receive could decrease and leave you without enough to live on. Also you might not be able to get a good rate on your next product.
• Inflation could increase – unless you add inflation protection, you may find that the income you receive isn’t enough to live on if inflation rises.
• Exit fees – if you decide you want to move your money before the end of the term, it’s likely you’ll be penalised.
• Not always cost-effective – you might get more for your money with a different investment.

As with all investment products, fixed-term annuities do come with risks. Your independent financial adviser can recommend the best way to set up your income in retirement.